Do foreign institutional investors influence corporate climate change disclosure quality? International evidence

• Published date: 01 March 2024
• Author: Sudipta Bose,Edwin KiaYang Lim,Kristina Minnick,Syed Shams
• Date: 01 March 2024
• DOI: http://doi.org/10.1111/corg.12535

SPECIAL ISSUE ARTICLE

Do foreign institutional investors influence corporate climate

change disclosure quality? International evidence

Sudipta Bose

1

| Edwin KiaYang Lim

2

| Kristina Minnick

3

| Syed Shams

4

1

University of Newcastle, Callaghan, Australia

2

Deakin University, Geelong, Australia

3

Bentley University, Waltham, Massachusetts,

USA

4

University of Southern Queensland, Darling

Heights, Australia

Correspondence

Kristina Minnick, Bentley University, Waltham,

MA, USA.

Email: kminnick@bentley.edu

Abstract

Research Question/Issue: We examine the association between foreign institutional

ownership and climate change disclosure quality from 2006 to 2018 across 34 coun-

tries. We find that firms with a higher level of foreign institutional ownership demon-

strate better quality climate change disclosures, whereas domestic institutional

ownership has immaterial impacts on such disclosures. We utilize a difference-in-

differences (DiD) analysis using a firm's addition to the Morgan Stanley Capital Inter-

national (MSCI) index as an exogenous shock to control for endogeneity. Our findings

are robust to various other endogeneity controls. We also establish evidence on an

indirect effect of climate change disclosure quality in mediating the positive associa-

tion between foreign institutional investors and firm valuation.

Research Findings/Insights: We find that the positive association between foreign

institutional ownership and climate change disclosure quality is more pronounced for

(1) firms domiciled in stakeholder-orientated countries, (2) firms domiciled in coun-

tries that adopt emission trading schemes, and (3) firms with a greater level of infor-

mation asymmetry. Additionally, our results are more robust when foreign investors

are domiciled in countries that care more about the environment.

Theoretical/Academic Implications: Our study contributes to climate change disclo-

sures, corporate governance, and international business literature by showing that

foreign rather than domestic institutional investors contribute to improved corporate

climate change disclosure quality in their portfolio firms.

Practitioner/Policy Implications: Our study urges regulators to increase their market

oversight, especially in firms with less foreign institutional ownership. This is required

because such firms are prone to exhibiting poorer accountability for their climate risk

management practices, and their disclosures are bereft of effective external monitor-

ing mechanisms.

KEYWORDS

corporate governance, CDP, climate change disclosures, cross-country, firm valuation, foreign

institutional ownership

[Corrections made on 02 June 2023, after first online publication: The second author's name and authors' biographies have been corrected and updated in this version.]

Received: 17 August 2022 Revised: 29 March 2023 Accepted: 25 April 2023

DOI: 10.1111/corg.12535

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium,

provided the original work is properly cited.

© 2023 The Authors. Corporate Governance: An International Review published by John Wiley & Sons Ltd.

322 Corp Govern Int Rev. 2024;32:322–347.

wileyonlinelibrary.com/journal/corg

1|INTRODUCTION

“Once an issue for ‘green funds’…ESG and climate are

now firmly established as high priority issues [for inves-

tors].”(Baer Pettit, MSCI president)

Institutional investors are increasingly focused on environmental

issues such as climate change and environmental disclosures (Carbon

Disclosure Project [CDP], 2018; Krueger et al., 2020; Matsumura

et al., 2014). For instance, BlackRock requires firms in its portfolio to

disclose, monitor, and manage climate-related risks (CDP, 2018;

Krueger et al., 2020). By integrating sustainability and climate change

factors into its investment approach, BlackRock creates transparency

in portfolio firms by encouraging disclosure of climate risks and

environment-related policies. One consideration when assessing the

effectiveness of institutional investors in improving disclosure is

whether they are foreign or domestic investors. Aggarwal et al. (2011)

show that institutions based in non-US countries with strong protec-

tions for minority shareholder rights improve firm-level governance.

Institutional investors with different geographic origins may have dif-

ferent monitoring incentives. Foreign investors are more likely to be

exposed to uncertainty and information asymmetry than local inves-

tors; consequently, they may demand more transparency around cli-

mate issues. In this study, we investigate whether foreign institutional

investors fundamentally drive the quality of firms' climate change

disclosures.

The motivation for our study is twofold. First, extant studies have

observed inconclusive evidence on the relationship between institu-

tional ownership and the quality of climate change disclosure. For

instance, Cotter and Najah (2012) focus on the largest 500 FTSE

global index firms and find that institutional owners successfully

prompt investee firms to disclose climate change risks. However,

Stanny and Ely (2008) find no significant impact of institutional own-

ership on carbon disclosures by US firms, while Ott et al. (2017) did

not find significant associations between institutional ownership and

firms' CDP response in an international setting. Liao et al. (2015)

observe a negative association using the UK sample, suggesting that

institutional investors deter such disclosures. These studies have col-

lectively treated institutional investors homogenously, potentially

accounting for the mixed and ambiguous evidence. To overcome this

limitation, we seek to determine whether these inconsistent results

are driven by the domicile of investors, that is, foreign versus domes-

tic institutional investors, recognizing the heterogeneity in their infor-

mational advantage and monitoring incentives or effectiveness (Baik

et al., 2013; Kim et al., 2019; Tsang et al., 2019).

1

Second, most studies have investigated how a country's informa-

tion environment attracts and influences foreign institutional inves-

tors' investment decisions (e.g., Aggarwal et al., 2005; Covrig

et al., 2007; Leuz et al., 2009). However, Kim et al. (2019) claim there

is a dearth of research examining how foreign institutional investors

influence the information environment of investee firms once they

have invested in such businesses. We extend this literature by exam-

ining whether foreign institutional investors promote more

transparency in the disclosure quality of climate change for firms in

their portfolios versus domestic investors. Exploring this is important

since policymakers want to understand how effective corporate gov-

ernance mechanisms promote climate change disclosures. Such mech-

anisms can reduce information asymmetry, stabilize financial systems,

and facilitate the nation's smooth transition to a low-carbon economy

(CDP, 2018; World Economic Forum [WEF], 2019).

This study focuses on the quality of climate change disclosures to

the CDP. Firms can disclose climate risks via various communication

channels such as corporate annual reports, corporate sustainability

reports, or responses to the CDP (previously, Carbon Disclosure Pro-

jects) questionnaires. While companies' annual reports are subjective

and not uniform (Gray & Bebbington, 2000), the CDP questionnaires

are standardized, structured, and formatted responses, which provides

us with a level platform to evaluate the quality of climate change dis-

closures (Ben-Amar et al., 2017; Depoers et al., 2016). As Ott

et al. (2017, p. 15) point out, the standardized nature of the CDP dis-

closure “provides a globally consistent, though voluntary, disclosure

standard.”

2

Our sample covers 34 countries from 2006 to 2018. In our base

estimations, we observe a positive association between foreign insti-

tutional ownership and climate change disclosure quality but do not

find a similar association for domestic institutional ownership. A chal-

lenge for institutional investor studies is to isolate the impact of own-

ership from confounding factors around the same time. To address

this issue, we also use a quasi-natural experiment that arises from the

firm's addition to the Morgan Stanley Capital International (MSCI)

index as an exogenous shock to institutional ownership.

Our results withstand several robustness tests, including control-

ling for the firm- and country-fixed effects, a change specification,

and a two-stage least squares (2SLS) regression with the instrumental

variable approach. We further find that the positive association

between foreign institutional ownership and climate change disclo-

sure quality is accentuated for firms domiciled in stakeholder-oriented

countries or those with emission trading schemes (ETSs) potentially

because of pressure from stakeholders and regulators. The positive

association between foreign institutional ownership and climate

change disclosure quality is also more pronounced for firms exhibiting

information asymmetry. Specifically, we show that the relationship

between foreign ownership and higher climate change disclosure

quality is more robust for firms displaying greater bid–ask spread and

operating in countries prone to earnings management practices. How-

ever, the relationship is weakened when firms have more analysts fol-

lowing or are cross-listed due to an existing informational and

monitoring environment facilitated by external parties. Finally, we find

that climate change disclosure quality is a potential channel that

explains the relationship between foreign institutional ownership and

firm value.

We explore why foreign investors may push for better climate

change disclosure to understand our results. Existing literature shows

that investors focused on environmental issues may be able to directly

influence their portfolio firms' carbon footprints (Azar et al., 2021).

We examine whether investors from more developed countries or

BOSE ET AL.323